Oklahoma State Tax Deduction May Benefit Trucking and Logistics PTEs
Oklahoma recently enacted legislation that allows pass-through entities (PTEs) to elect to pay state income tax at the entity level. The reason why PTE owners would want to consider this election is because 2017 federal tax reform legislation capped the itemized deduction for state-level income, property, and other taxes imposed at the individual level at $10,000 per return, but imposed no such limitations on businesses. As a result, Oklahoma’s new Pass-Through Entity Tax Equity Act of 2019 effectively shifts state tax on pass-through income from the individual to the business itself, and thus eliminates the $10,000 cap on the related federal itemized deduction.
Any PTE required to file an Oklahoma partnership or S corporation income tax return can elect to use entity-level income taxation starting with tax years beginning in 2019. To be effective for the 2019 filing, however, the election must be made by June 28, 2019.
Trucking and logistics companies are particularly susceptible to the intricacies of state tax laws, so be sure you understand how this election works and whether or not it’s truly advantageous to your company.
How the election works
Once the election is made, the PTE will be taxed on its Oklahoma income at the PTE level instead of at the individual level (as in the past). Because of this, the tax will be deductible on the PTE’s own federal income tax return. This is particularly beneficial for business owners that have already met the $10,000 state tax cap on their individual returns.
There is a catch
However, the Oklahoma tax rate for the electing PTE will be the highest marginal individual income tax rate, which is currently 5 percent, of the electing pass-through income that is distributed to individuals, trusts, or estates. For individual owners of a PTE who did not make this election, Oklahoma income tax would instead apply at the state’s graduated rates. While this would result in an increase in the owners’ total Oklahoma income tax burden, the resulting federal income tax benefit would often outweigh this state-level increase. The tax rate for the electing PTE will be 6 percent of the income distributed to a corporation.
Avoiding double taxation
To avoid double taxation in Oklahoma for electing PTEs and their owners, any Oklahoma-sourced income or loss used in computing the PTE’s entity-level income tax would not be allocated to the respective owners. A modification will be allowed against the Oklahoma taxable income (for corporate owners) or adjusted gross income (for individual owners) for any Oklahoma income or loss that would otherwise be allocated to a member or indirect member of the electing PTE.
However, to avoid double taxation by Oklahoma and other states, if one or more owners of an electing PTE resides in another state that imposes an income tax, those owners should ensure that their states of residence permit credits for the Oklahoma PTE entity-level tax.
Electing nonresidents no longer required to file
Before this act was passed, nonresidents of Oklahoma were required to file an Oklahoma individual tax return to report the income from the PTE. If this election is made, that requirement is eliminated so long as all of their Oklahoma-sourced income is reported, and taxes are paid, at the pass-through level.
A trucking and logistics industry example
ABC Trucking Company (ABC), an S corporation, has one owner who is a Minnesota resident. ABC reports taxable income of $1,000,000 on its federal S corporation income tax return (Form 1120S). Five percent of ABC’s miles are driven in Oklahoma, and the company has no state tax differences between its federal and Oklahoma returns. Thus, ABC has Oklahoma-sourced net income of $50,000.
If ABC does not make the PTE election, it would file an Oklahoma S corporation return and pass $50,000 of state income to its nonresident owner. Since the nonresident owner files as “married filing jointly,” the nonresident Oklahoma tax comes to $2,145 under the graduated rate table. The nonresident owner has paid other state taxes (e.g., property taxes) well in excess of the $10,000 cap, so he will get no tax deduction on his federal income tax return for the Oklahoma nonresident tax paid.
If ABC does make the PTE election, the $50,000 income sourced to Oklahoma would be taxed at the highest marginal individual tax rate of 5 percent, which would come to $2,500. Since this tax is at the PTE level, the $2,500 is deductible on ABC’s 1120S return. Assuming ABC’s income qualifies for §199A, ABC’s nonresident owner would save $740 of tax ($2,500 x 29.6 percent tax rate) on his federal income tax return. ABC would end up paying more tax to Oklahoma, but it would save on taxes paid overall.
How the election is made
An eligible PTE can make the election on Oklahoma Form 586. The election is binding until it is revoked by the PTE or by the Oklahoma Tax Commission. A PTE can also revoke the election in the future on Oklahoma Form 586.
An “electing pass–through entity” means any PTE (general partnership, limited partnership, limited liability partnership, limited liability limited partnership, limited liability company, or corporation) that is required to file an Oklahoma partnership or S corporation income tax return.
Election due dates
PTEs that wish to make the election for tax years that begin prior to January 1, 2020, the election must be made no later than June 28, 2019. For tax years that January 1, 2020, or later, the election must be made no later than the 15th day of the second month following the beginning of the tax year. This would be February 15, 2020, for the 2020 calendar year-end.
How we can help
Tax reform is the legislation that launched a thousand state laws. Oklahoma’s new tax act is one of many. Be sure you understand how each new state regulation interacts with federal rules — and how you can use them to your advantage to save money and reinvest it in your business or your personal future.
State and local tax laws are particularly troublesome for trucking companies. CLA’s transportation and logistics professionals can work with you to assess the impact of Oklahoma’s new law on your business and help determine if this is an election that you should make.